SOME OF THE CURRENT PENSION CHALLENGES
The sustainability and adequacy of pension systems depends on the degree to which they are underpinned by contributions, taxes and savings from people in employment. Financingarrangements, eligibility conditions and labour market conditions must be calibrated such that a balanced relation between contributions and entitlements, and between the number of actively employed contributors and the number of retired beneficiaries, can be achieved.
Securing the financial sustainability of pension systems
Pensions represent a very large and rising share of public expenditure: more than 10% of GDP on average today, possibly rising to 12 ó % in 2060 in the EU as a whole2. But with spending on public pensions ranging from 6% of GDP in Ireland to 15% in Italy today, countries are in rather different situations although they face similar demographic challenges.
In the last decade, there has been considerable progress in reforming pension arrangements. A majority of Member States have adapted pension systems so as to put them on a more sustainable footing and enable them to weather the demographic changes that are set to take hold. This has been implemented through reforms that aimed to make the parameters of the systems consistent with fiscal sustainability, or through structural reforms such as shifting from defined benefit (DB) to defined contribution (DC) schemes or establishing mandatory funded pillars.
However, further reforms are in many cases necessary and the financial and economic crisis has made the demographic changes harder to cope with, as well as highlighting further weaknesses in some pension systems. So further adjustments on the expenditure side will be unavoidable in many Member States together with enhanced efforts to boost employment rates and productivity. A credible fiscal strategy needs to be rigorously implemented in line with the fiscal framework in the Stability and Growth Pact, taking due account of the net cost of implementation of a pension reform. Regarding the challenge of population ageing, the Stockholm European Council defined a three-pronged strategy in 2001, comprising: (i) public debt reduction, (ii) increasing employment, notably of older workers, and productivity and
(iii) reforming social security systems. Recently, the three-pronged strategy to cope with the challenge posed by ageing populations was enriched in the context of the overall Europe 2020 strategy, while the 2010 Green Paper on Pensions launched a debate on a comprehensive approach in view of delivering adequate sustainable and safe retirement incomes.
Maintaining the adequacy of pension benefits
Pensions – mostly from public schemes – are the main source of income of older Europeans, who are a significant and growing part of the EU population (120 million or 24%). Indeed, the basic purpose of pension systems is to deliver adequate retirement incomes and to allow older people to enjoy decent living standards and economic independence and pensions also play a role as automatic stabilisers.
Broadly speaking, this has been achieved across the EU, although important gaps remain. People over 65 have an income of almost 94% of that of the average for the total population, yet about 22% of women over the age of 75 fall below the at-risk-of-poverty threshold. While recent public pension reforms have tended to improve or maintain their poverty protection, most of these reforms will result in lower replacement rates (pensions relative to previous earnings) in the future.
Projected change in replacement rates of statutory and supplementary pension schemes between 2008 and 2048 (in pp.)
The expected reduction in replacement rates is, however, based on the assumption of an unchanged retirement age. Working to a higher age may help maintain or even increase the future level of replacement rates. This effect is illustrated in figure below which compares the gross replacement rates received by people retiring currently at 65 after a 40-year career with replacement rates of people retiring at a higher age (67, after a 42-year career with all other elements assumed alike) in the future.
Projected impact of longer working on change in replacement rates between 2008 and 2048
Complementary retirement savings can also help secure adequate replacement rates in the future5. Some countries have introduced measures to complement their public pay-as-you-go pension schemes with private funded schemes, but there is much scope for further development of complementary pension savings opportunities in many Member States. This would require, though, that funded private pension schemes become safer and more costeffective, as well as more compatible with flexible labour markets and mobility.
In some countries the crisis clearly demonstrated that the ability of pre-funded pension schemes to mitigate risks and absorb shocks needs to be improved. The recession and the subsequent deterioration of public finances also revealed some weaknesses in the way some Member States had sought to build mandatory private pension schemes.